How will the UK Interest Restriction operate?

This was the question posed at the ‘Interest Deductibility Conference’ held by the Oxford University Centre for Business Taxation at the Royal School of Chemistry on Piccadilly a couple of weeks ago, when the great and the good of the tax world gathered to discuss the proposed interest restriction.

The concept of a restriction is borne out of two main concerns:

a) That UK companies borrow money and use this to acquire shares in overseas entities, receiving a deduction for the interest whilst the income from those shares is generally exempt.

b) The use of intra group debt to create excessive levels of interest deductions.

Much of the debate revolved around whether an interest restriction, set at an arbitrary rate, actually deals with either of those two problems. The overarching feeling in the room was that these two concerns were either already dealt with by existing legislation, or were not as prevalent as perhaps the tax authorities considered. In particular there was some surprise that it was felt that thin capitalisation rules did not deal with concern B above – albeit the HMRC representative in the room suggested that this was because other countries did not have as robust thin cap regimes as the UK (remembering that the interest restriction is an OECD BEPS recommendation).

The other main subject of debate in the room was the impact upon infrastructure projects. The restriction of interest deductions on large infrastructure projects drives down the return on capital and may change investment decisions – in other words some projects may not get the required level of funding. The government has acknowledged the need to grant such projects a special dispensation but there is currently no clear guidance on what a ‘qualifying infrastructure project’ will look like.

Of course this being an Oxford University hosted event meant that there was some academic input, in particular the proposal of an ‘ACE’ (allowance for corporate equity). This is a calculation which allows a tax deduction for a certain percentage of share capital, loan capital and accumulated profits.

For a tax adviser dealing with clients at the larger end of the SME market I’ve been asked a number of times as to whether I think the restriction will actually end up affecting small and medium sized business. At the moment whilst it is clear that there will be a bar below which the restriction will not be applied, it is not clear how this bar will be set – the EU SME test has been suggested as has a net interest expense of £1m per group.

For the moment the waiting continues and we will see what HM Treasury come up with, probably on or shortly after 16 March 2016 – Budget Day!!!

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